Treasury yield curve flattest since 2012

Market begins to reassess reaction to Fed meeting

NEW YORK (MarketWatch) — The differential between intermediate and long-term Treasury yields narrowed to its lowest since 2012 on Friday, reflecting a more hawkish than expected Federal Reserve meeting this week, even as signs emerged that the market was rethinking its knee-jerk reaction to the central bank.

The difference, or spread, between the 5-year Treasury
US:5_YEAR
yield, which rises as prices fall, and the 30-year Treasury
US:30_YEAR
yield dropped to 1.90 percentage points from 2.08 percentage points on Tuesday, extending a fall since last November, when it peaked at 2.54 percentage points. The spread is now the smallest since August 2012 on a closing basis, according to Tradeweb.

The flattening of the yield curve suggests growing expectations that the Federal Reserve will normalize monetary policy, with investors moving up forecasts of when the central bank will begin raising its key policy rate. That sent intermediate-term Treasury yields sharply higher in recent days, even as long-term yields fell.

Fed Chairwoman Janet Yellen added in a news conference that rate increases could come roughly six months after the central bank finishes winding down its bond-buying stimulus program, expected to conclude before the end of the year. Intermediate-term Treasury yields jumped on that news and held on to those gains.

The Treasury curve, “did reprice due to perceived heightened short term rate risks which has seen curves flatten,” said Adrian Miller, director of fixed-income strategy at GMP Securities, LLC, in a note to clients.

Nonetheless, signs emerged that the market was rethinking its initial reaction, with intermediate term yields turning lower Friday afternoon. The 5-year Treasury yield, which falls as prices rise, was down half a basis point at 1.707%. It rose roughly 18 basis points on the week. The 3-year Treasury
US:3_YEAR
yield rose half a basis point to 0.897%.

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“So far the response has been muted, but you are seeing a little bit of a turn of the market, and there has been better buying” this afternoon, said Jason Rogan, managing director of U.S. Treasury trading at Guggenheim Securities. “You are seeing some unwinds of carry trades that people had on.”

Goldman Sachs Chief Economist Jan Hatzius said he still doesn’t believe rate hikes will begin until early 2016, which is well after the market expects. “We do not think that Yellen meant to send a strong signal of a shift in the reaction function,” he wrote in a note to clients.

Intermediate Treasury yields briefly turned higher after St. Louis Fed President James Bullard said at a press conference that the six-month lag between ending bond-buying and beginning rate hikes that Yellen mentioned is not very different than prevailing expectations.

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